Zero-Downpayment. Unsafe?

Does it makes sense to think the key to preventing potential foreclosures is to require borrowers to put a substantial down payment down when purchasing a home? In other words, borrowers need to have “skin in the game”, right?

Below are a few things that say there is something wrong with that conclusion.

1. VA home loans are bragging that they have the mortgage lending’s lowest foreclosurerate even though about 90 percent of their borrowers did not put a down payment down. These borrowers got 100% financing. The VA mortgage foreclosure rate for 4th Quarter 2012 was only 2.08 percent. The foreclosures for prime loans was 2.10 percent and FHA loans was 3.85 percent. There are a few reasons the VA loans have the lowest foreclosure numbers. Here they are:

VA requires its loan servicers and lenders to work with the military families and offer them forbearance, mortgage modification, and other foreclosure mitigation.

Military families view “strategic defaults” on a VA-backed loan as un-American.

2. For several years, the USDA’s Rural Housing programs that offer 100% financing have a very low foreclosure rate (1.7%). This is so low because if borrower default, they would face extreme hardship. These borrowers would be subject to incredibly severe collection tactics. They could have their tax returns seized, up to 15% of borrowers take-home pay and/or 15% of Social Security payments taken from them.

For the reasons noted above, it might not be a good strategy to default on their loan. These repercussions keep these borrowers honest!

3. The 2010 Federal Reserve Study notes that the borrowers in California, Nevada, Arizona, and Florida who received 100% financing, 80% of those that defaulted experienced an income shock and negative equity. There is a group of individuals that defaulted due to negative equity, they are called strategic defaulters. A majority of the strategic defaulters did not default on their loan until they were 50% or more under water. Even borrowers that received 100% financing were not willing to strategically default until they had at least 50% negative equity. These folks had NO skin in the game! If homes are going to be over 50% underwater, it won’t matter if the borrower puts an extra 5% down when purchasing a property.

Stopping people that do not have a ton of cash for a down payment is not what needs to be done to prevent another mortgage crisis. Instead, we should ensure that mortgage applicants are thoroughly underwritten and those that can prove they have stable income and have shown they are BOTH willing and able to pay their obligation in full and on time should qualify for mortgage loans. Another avenue that could decrease strategic defaults is to make it more difficult for borrowers to walk away from their property. There should be some level of recourse for those that decide to just walk away from a property in which they have significant negative equity.

Mortgage borrowers should not be required to have a ton of cash to put down, but should be individuals with integrity.